The Stock Market and the Dollar Sustain the Bullish Environment for Precious Metals

This week marked the Year of the Dragon in the Chinese calendar, and according
to Chinese mythology, Dragon years bring powerful changes and optimism representing
imperial power, prosperity and good luck. This year is supposed to be even
more auspicious since it's a Water Dragon year, something that occurs once
every 60 years. We admit that we don't yet use the Chinese Horoscope as a technical
indicator, and who knows, perhaps we should. One thing is certain--the Year
of the Dragon began with an auspicious move for precious metals. The dragon
that breathed fire into precious metals prices was the Federal Reserve which
announced this week that it is planning to keep interest rates at rock bottom
for some years and hinted at further economic stimulus measures. Gold prices
hit 6-1/2 week highs on Thursday as stock markets, commodities and the euro
all rallied. This followed Wednesday's biggest one-day rise in three months
after the Fed said it might consider further monetary easing through bond purchases
(creating fiat currency out of thin air) and pushed back the likely timing
of an eventual interest rate hike to late 2014.

Since many view a U.S. rate hike as a kiss of death to the gold bull market
(we disagree), the news that it won't happen for at least three more years
prompted those on the sidelines to join the ride. Gold closed above its 100-day
moving average, a technical factor that further boosted confidence.

The Fed said in a statement that the economy had expanded "moderately" in
recent weeks, but that unemployment remained at a high level, the housing sector
remained in a deep depression, and the possibility of a new financial crisis
in Europe continued to threaten the domestic economy.

Usually after the Asian gold buying binge for the Lunar New Year gold demand
tends to drop along with winter temperatures. We have reasons to believe that
will not be the case in the short term. Generally, central bank demand is not
subject to seasonality (although one could argue about the business and election
cycles impact). Accumulation by countries has removed several hundred tons
of gold from the market in each of the past two years and there is no reason
to think that this year will be different. Central banks use periods of price
weakness to step up their buying which reduces downside risk for all of us
while setting the stage for sizable snap-backs. Central banks around the world
added 157 tons to their holdings in the six months through November, recent
World Gold Council data show.

The gold accumulated by Chinese for the Year of the Dragon is not likely to
go back into the world market since most Chinese savers and investors buy gold
as long-term, quasi-permanent holdings. That coupled with buying by central
banks whose holding periods can be measured by decades, means that there is
less supply and any rise in demand for jewelry is likely to have a greater
effect on the metal's price than might have been the case several years ago.

To see if the Year of the Dragon will be as auspicious as millions of Chinese
believe it will be, let's turn to the technical part with the analysis of the
USD Index. We will start with the very long-term chart (charts courtesy by http://stockcharts.com.)

Our first chart today is the very long-term USD Index chart. There has been
virtually no change within the past week, but we can clearly see that the recent
breakout above the long-term resistance line is being verified or invalidated
at this time. The latter is more likely (70% probability or so) since the recent
breakout was not confirmed. A reversal to the downside is more probable and
likely underway already.

In the short-term Euro Index chart, we see a confirmation of the recent breakout.
Recently, we have discussed the lack of a confirmation and a possible breakout
in the Euro Index. Several days of closing prices above the support line without
any significant moves to the downside not only confirm the breakout, but they
also point to strength in the Euro Index at this time - actually that's more
likely weakness in the dollar that we're seeing here, as currency exchange
rates are ultimately relative valuations of currencies against each other and
the recent statement from the Fed did not help to boost confidence in the greenback.

In the long-term S&P 500 Index chart, the self-similar pattern which we've
been discussing for a few months with our subscribers has continued to play
out well. If this goes on, the next local top will probably be close to the
level of the 2011 high. The recent trading pattern has been consistent with
the period leading up to the local top in 2010-11. In October-November 2010,
declining prices were seen for a few weeks but were quickly followed by a continuation
of the rally. We may have a similar situation here.

RSI levels should be looked at as well and are also indicating that a rally
is likely ahead. It appears that it could last for two to four weeks as the
RSI level will then likely be close to 70. This has coincided with local tops
in the past.

A brief explanation of how the Correlation Matrix worksis to be found in our
last essay on the US
dollar's influence on gold. Significant changes have been seen here this
week. The short-term correlation between the USD Index and the precious metals
is rather weak and can be attributed to the strong European demand for gold.
The yellow metal's price has rallied in all currencies and the correlation
between the dollar and gold's price has therefore weakened.

A declining USD Index is medium-term bullish for gold and the precious metals,
and the coefficient in the 90-day, medium-term column indicates this. The precious
metals and the general stock market both have bullish outlooks at this time
and several of their coefficients reflect this although the relationship cannot
be described as strong. It seems best at this time to look directly at the
precious metals themselves in order to analyze their likely short-term and
long-term trends as we do in our full analysis.

Summing up, the breakout in euro above the short-term declining resistance
line has been confirmed, which is bullish for euro and bearish for dollar.
The situation for the general stock market is a bit unclear for the next few
days, but the outlook remains bullish for the weeks and months ahead. Based
on correlations, these factors do not disrupt our bullish view on the precious
metals sector.

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Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who
takes advantage of the emotionality on the markets, and invites you to do
the same.

His company, Sunshine Profits, publishes analytical software that anyone can
use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem
that may never be solved, PR has changed the world of trading and investing
by enabling individuals to get easy access to the level of analysis that
was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are
results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals
sector. For that reason it is his main point of interest to help you make
the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for
professional excellence and ethics for the ultimate benefit of society.

Disclaimer: All essays, research and information found above represent
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